Structured Finance and the Social Contract: How Tranching Challenges Contractualist Approaches to Financial Risk

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Abstract

Many ethicists argue that contract theory offers the most promising strategy for regulating risks. I challenge the adequacy of the contractualist approach for evaluating the complicated, novel risks associated with some structured financial products, particularly focusing on risks to third parties. Structured financial products like collateralized debt obligations (CDOs) divide a pool of financial assets into risk "tranches" organized from least to most risky. Investors purchase various tranches based on their individual risk-and-return preferences. Whereas contract theory holds that investment risks are ethically permitted (roughly) when everyone - including both parties directly involved in the investments and third parties - consents to them, structured financial products like CDOs show that even risks to which everyone consents are ethically problematic when they involve systemic risks of ruin.

Original languageEnglish (US)
Pages (from-to)1-24
Number of pages24
JournalBusiness Ethics Quarterly
Volume29
Issue number1
DOIs
StatePublished - Jan 1 2019

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics
  • Philosophy
  • Business, Management and Accounting(all)

Keywords

  • collateralized debt obligations
  • contractualism
  • ethics of risk
  • structured finance
  • systemic risks of ruin
  • third-party risks

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